Months into a long-overdue exploration of energy prices, few commentators or
analysts seem to mention issues related to the long history of affordable oil
and the capital and labor substitution.
The age of oil has been a period of rapid and rapidly rising production of
goods, services and wealth. The ability to harness technology-driven
productivity and output enhancement has transformed the world in wave after
wave. The vast quantities of wealth produced and the enormous increases in
human population, food output, longevity, literacy and health all attest to
this. Abundant and price-competitive energy was substituted for

human physical labor in industry after industry, nation after nation.
The very success and extent of this process has created the demand increase
that is partially driving oil, coal and natural gas prices today. There are
implications for the relations between capital and labor, wages and profits.

Abundant, reliable and cost-competitive new technologies must be run on
abundant, reliable and cost-competitive energy inputs. The length and scale of
present energy price increases threatens to begin to alter the profitability
and desirability of marginal-production processes.

Most commentators don't focus on substitution between capital and labor in the
face of energy price increases. The longer prices stay high, and the higher
they go, the more important this area is to explore.

Skill-biased technical change and globalization have influenced the split
between wages and profits. Rising productivity has created the possibility of
rising wages and profits. Sometimes this possibility becomes reality, sometimes
it does not. Lately, in the US and abroad, the gains to productivity have gone
more toward profits than wages. This makes clear that abundant, reliable and
affordable energy has allowed greater wealth to be produced and a greater share
of that greater wealth has been captured by profits. Rising energy prices could
pressure this in two ways.

Energy prices are, directly or indirectly, input costs into most goods and
services production. Sustained and significant energy cost increases eventually
become higher food and living costs. We are already at least nine months into a
significant acceleration in expected energy and food-price increases. If wages
don't rise, an increasing portion of incomes will be redistributed to food,
energy and costs related to food and energy.
This will act like a wage reduction to the extent that it is difficult for
consumers to find suitable and stable-priced substitutes for food and energy.
Systematic wage increase demands cannot be held off indefinitely. Rising
unemployment may reduce demands but costs of living apply persistent and acute
pressure.

Meanwhile, companies' costs of inputs are pressured up by rising prices and by
increasingly strained basic operational planning and design born of assumptions
about cheap, reliable energy and labor. Past imbalances between profit and wage
gains from productivity are likely to increase demands for wage hikes. Further
massive substitution of technology for labor will be more difficult as
consumers struggle under high food and energy costs as firm costs rise.

Production processes with significant energy and labor cost components should
be expected to be hit hardest and first. Here we might take airlines as the
canary in the coal mine. We might also look hard at a Chinese economic model
that relies on abundant, inexpensive labor and energy with a voracious appetite
for distance-shipped raw materials and final products.

The long-term massive substitution of technology-driven innovation, fueled with
cheap wages and energy, may be at increasing risk. Rising energy costs are hard
to substitute around. Labor is an obvious substitute in relatively few cases.
That may change on the margin. More broadly, high and rising energy prices may
begin to pressure the divisions between wages and profits through direct
business costs and wage demands.

The past three decades in America have been defined by rapid technological
change, profit-biased output growth and generally cheap and abundant energy.
Clearly, the world will not change overnight and energy prices have not
attained - nor will they likely in the near future attain levels - sufficient
to decimate major structural pillars of modern economies. It may nevertheless
be getting toward a point where we entertain discussion of the implications of
energy prices for inflation, wage rates and profits on a macroeconomic level.

Max Fraad Wolff is a doctoral candidate in economics at the University of
Massachusetts, Amherst, and editor of the website GlobalMacroScope.